The House of Morgan: An American Banking Dynasty and the Rise of Modern Finance

by Ron Chernow

  For the most part, Morgan Stanley had sat out the conglomerate wave of the 1960s. This movement attempted to reduce diverse companies to a common calculus of profit and loss. Conglomerates threw together scores of unrelated businesses to bypass antitrust restrictions that might block intra-industry mergers. The craze remade the corporate landscape, creating eighteen of America’s one hundred largest companies; twenty-five thousand businesses vanished in the 1960s. Many takeovers were financed by inflated share prices of the conglomerates themselves—financial hocus-pocus that made Morgan Stanley nervous. The firm wasn’t really pressed to participate in the craze. Most conglomerates were acquisitive upstarts and not the staid, blue-chip firms on the Morgan Stanley client roster.

  Corporate restructuring was still curbed by Wall Street etiquette, which frowned on unsolicited takeovers. Afraid of conflicts with clients, Morgan Stanley had a rule against hostile takeovers. In 1970, it nearly engaged in its first hostile bid when Warner-Lambert decided to take over part of Eversharp’s shaving business; in that case, the mere threat of a hostile takeover made the target submit. So Morgan Stanley’s taboo-breaking hostile raid was postponed until 1974, when International Nickel (Inco) pursued the Philadelphia-based ESB, formerly called Electric Storage Battery.

  By this point, an ambitious young partner named Bob Greenhill headed the four-man M&A Department. He had reluctantly entered the takeover area, regarding it as a slow track to the top. Then he saw there was money—lots of money—to be made. As Wall Street’s first takeover star, Greenhill would rewrite the rules of the game. He wanted the work to be tough, professional, and extremely disciplined. Most of all, he wanted it to be profitable and not a lagniappe thrown to a favored client. While some older partners still wanted to offer merger service free, Greenhill, Yerger Johnstone, and Bill Sword devised a fee schedule that took a percentage of the money involved in a takeover. From now on, the firm would ask for retainers just to scout mergers, a process in which employees sat around fantasizing matchups.

  When merger work was a free service designed to preserve an underwriting relationship with a client, the investment banker had no incentive to approve or reject a takeover, thus guaranteeing his objectivity. Now the incentive system was quite heavily loaded toward advocating takeovers. The bigger and more frequent the takeover, the more profit for Morgan Stanley. The new fee-for-service mentality directly related to the declining importance of underwriting. If blue-chip clients brought in less bond business, why pamper them with extras? “We charge for the services we provide,” Lewis Bernard explained. “When a client asks us to take on an assignment, we expect to get paid for it.”31

  Son of a Swedish immigrant and Baltimore clothing-company owner, Bob Greenhill came to Morgan Stanley via Yale, Harvard Business School, and the U.S. Navy. He was one of the “irreverent six” who participated in Bob Baldwin’s bloodless coup. In the navy, he was called Greenie, and he remained so called at Morgan Stanley, a firm with a preppy relish for nicknames. (Baldwin was Baldy.) Short and trim with curly hair, powerful shoulders, and a narrow waist, he had a boyish grin that masked an obsessive intensity.

  Greenhill personified the rock-’em, sock-’em style that would characterize Wall Street in the 1980s. He came alive in combat, and his stamina in all-night bargaining sessions was mythical. He was tailor-made for financial warfare. A former partner declared: “Bob is smart and completely insensitive. He couldn’t care less what you think and he has no need for peer acceptance or approval. He marches to his own drummer. He’s very rational, very focused. On the wall of his office, he has an Al Capp cartoon showing Fearless Fosdick riddled with bullets. The caption is MERE FLESH WOUNDS.’ That’s how Bob sees himself.” Once called the “ultimate samurai,” Greenhill had qualities that made him a formidable negotiator but a trying person. Another former partner remarked, “Bob knows he’s good and he talks down to clients. But CEOs can’t afford not to use the best. So they just decide to stomach him because he’s so good.”

  Greenhill was that Morgan rarity—a partner who emerges as a distinct personality in the public mind. Publicity accompanied transactional banking as naturally as secrecy did relationship banking. Where Morgan style of dress had been aloof and understated, Greenhill wore suspenders monogrammed with dollar bills. (Surely Harold Stanley would have cringed!) He resembled a commando more than the martini-drinking Morgan banker of yesteryear. He was a resourceful, derring-do character. Once in Saudi Arabia, after missing a scheduled commercial flight, he hired a private plane just so that he and two other partners could make a dinner appointment in another Saudi city.

  Instead of tennis or golf, Greenhill liked solitary sports that tested endurance. Early each morning, he jogged near his Greenwich, Connecticut, home. He was also a motorcycle enthusiast. Once on a vacation, a bush pilot dropped him and several fellow canoeists into an icy river within the Arctic Circle. A month and five hundred miles later, the pilot rendezvoused with these wilderness explorers in the Atlantic. Green-hill’s takeovers resembled such holidays. As a friend told the writer David Halberstam, “Bob regards these battles as miniature Okinawas.”32 Greenhill savored a new rhetoric of corporate battle: “It’s important to know about a chief executive, whether he has the stomach for a fight. You see people with the veneer stripped away, in their elemental form.”33 The world of investment banking, once attractive for its leisurely elegance, was now a cockpit for pin-striped combatants.

  In 1974, Greenhill was field marshal for Morgan Stanley’s first hostile takeover—International Nickel’s raid on ESB, the world’s largest maker of batteries. It wasn’t the first unsolicited takeover in Wall Street history: what was the 1901 Northern Pacific corner if not a raid by Edward H. Harriman? But the auspices shocked Wall Street, for Inco was a conservative, blue-chip firm and Morgan Stanley was the official custodian of the Gentleman Banker’s Code.

  The old House of Morgan had long dominated mining, having financed Anglo-American; Kennecott; Anaconda; Newmont Mining; Phelps, Dodge; and Texas Gulf Sulphur. Inco’s plight typified that of Morgan Stanley’s mature mining clients. In the 1950s, the Canadian company had controlled an astonishing 85 percent of Western nickel output. By the 1970s, its monopoly was slipping. Buffeted by fluctuations in nickel and copper prices, management decided to diversify. After the 1973 Arab oil embargo, Inco was tantalized by Philadelphia-based ESB, and there was fanciful talk about electric cars powered by ESB car batteries, with Inco nickel powder in those batteries.

  It is important to note that the impetus for this landmark takeover originated not with Morgan Stanley but with Inco. Inco’s chief financial officer, Chuck Baird, had worked under Bob Baldwin as assistant navy secretary. It was Baird who convinced his superiors to undertake the ESB attack—with or without Morgan Stanley. By conducting such a raid, a new Inco management team wanted to shed the company’s stolid image. So the proposal came from a trusted client, putting Morgan Stanley on the spot.

  The merger business had boomed during the bear market of 1973-74. Hundreds of brokerage firms left the business, limousines disappeared from the canyons, and downtown rents plummeted. The Coachman Restaurant, a favorite luncheon spot, sported a sign that said ’ALL THE SALAD YOU CAN EAT” and “FREE FLOWING WINE.”34 Old-timers said the Street hadn’t been so cheerless since the 1930s. Yet for the investment banks, there were hopeful signs in the new stagflation—the combination of inflation and economic stagnation. Stagflation suddenly made it cheaper to buy companies on Wall Street than to invest in bricks and mortar. The age of “paper entrepreneurialism,” to use Harvard economist Robert Reich’s term, had arrived.

  The nearly forty Morgan Stanley partners (technically directors after the 1970 partial incorporation) debated whether to spurn Inco or defy a code that had governed the world of high finance for almost 150 years. The firm still moved by consensus in major matters. Against more squeamish souls, Greenhill had lined up Baldwin and chairman Frank A. Petito. Petito’s role was curious. Although nominally th
e firm’s chairman, Petito, shy and introverted, shrank from administration, ceding the task to Baldwin. Yet on important policy matters, his vote carried tremendous weight. He was very much the statesman and the conscience of the firm, inheriting the Harry Morgan role. Petito recognized the need for a new pugnacity. A revealing term had slipped into the Morgan Stanley lexicon: when Greenhill’s squad needed to prod a reluctant senior man into aggressive action, they said he needed to be japped—a reference to frank A. Petito.

  Greenhill made a pitch for hostile takeovers as an irresistible trend that was fair to shareholders, if not always to management. The argument of inevitability was probably the decisive one. As one partner recalls, “The debate was, if we don’t do what our clients want, somebody else will.” The partners were more receptive to this argument after Morgan Stanley’s work with Morgan Grenfell, and Yerger (ohnstone cited unsolicited raids in London as a precedent for America. Bob Baldwin agreed: “We did a lot of mental gymnastics about it. . . . When the water rises in London, it will soon flood New York.”35

  Frank Petito figured out how to twist the desecration of tradition into seeming veneration: in obliging Inco, the firm would simply be honoring an old Morgan tradition of serving faithful clients. But Petito had enough qualms about what they were doing to cast the upcoming Inco raid as an exception. A compromise was forged: the bank, in future, would engineer hostile raids only for existing clients and would fully warn them of unpleasant consequences. This, of course, didn’t rule out much business. Morgan Stanley’s large clients were just the sort that would now want to conduct raids, and they would know all about the unpleasant consequences. The compromise mostly reassured the firm’s clients that it wouldn’t be coming after them.

  At this juncture, Morgan Stanley made another unorthodox decision. Like Morgan Guaranty, the firm had long relied on the Wasp white-glove law firm of Davis, Polk, and Wardwell, which had looked on takeover work as vulgar and had avoided it. With Morgan Stanley partners terrified of lawsuits ensuing from takeover work, they now wanted a tough, seasoned specialist. Greenhill insisted on hiring the experienced Joe Flom of Skadden, Arps, Slate, Meagher, and Flom, whom he had met through Bill Sword. Flom was a short, friendly man in glasses who had attended Manhattan’s tuition-free City College, then Harvard Law. He pioneered in hostile takeovers in the 1950s, when Skadden, Arps was still a humble, four-man operation. For twenty years, he thrived on the scraps from law firms that were too haughty or too dignified to conduct hostile raids.

  When Flom was made a special counsel to Morgan Stanley, there were stormy scenes with Davis, Polk partners, who were deeply offended by the decision. Whatever its other consequences, the trend in hostile takeovers democratized the New York legal world and provided an opening in Wall Street for Jewish lawyers. Both Joe Flom and Marty Lipton of Wachtell, Lipton, Rosen, and Katz profited from the early refusal of old-line Wasp firms to sully their hands with takeovers. In time, Flom would earn $3 million to $5 million a year, and his law firm would end up as New York’s largest, with nine hundred lawyers. Flom would be integral to Morgan Stanley’s takeover machine. Greenhill later said, “we know each other’s jobs so well that we’re almost interchangeable.”36 In 1975, Morgan Stanley completed the incorporation process, not wanting to have unlimited liability with the risky Greenhill operation underway.

  As for the Inco raid—on July 17, 1974, Bob Greenhill called Fred Port of ESB to say that he and Inco representatives wanted to visit him in Philadelphia the next day. Port was about to depart for a Kenyan safari. Stunned, he privately dismissed Greenhill as a whippersnapper but canceled his plans. Inco’s outside directors didn’t learn about the imminent move until the next morning, when Chuck Baird and Greenhill briefed them. Approval was nearly unanimous; the sole holdout was Ellmore Patterson of Morgan Guaranty, who cited his board seat at Union Carbide, an ESB rival, as his reason for abstaining.

  The raiders then flew off to Philadelphia by helicopter. Their attack would be vintage Flom-Greenhill—a blitzkrieg that gave them the advantage of surprise, a tactic that worked wonders in the early days when they faced inexperienced executives. ESB’s Fred Port was shocked when told that Inco wanted to buy his company for $28 a share—a substantial premium over its $19 market price. When Baird added that they would proceed whether ESB liked it or not, Port flushed deeply.

  Enlisting the aid of Steve Friedman of Goldman, Sachs, Port issued a letter denouncing such ungracious behavior. Friedman, suspecting shame was now obsolete on Wall Street, advised Port either to fight on antitrust grounds or find a “white knight.” All at once, Morgan Stanley and Goldman, Sachs had settled into their respective slots in the takeover world. Representing the restless, mature giants who wished to diversify into other fields, Morgan Stanley took the offense. Associated with the more medium-sized and retail firms likely to be prey, Goldman, Sachs found its métier in defense. Billing itself the Robin Hood of Wall Street, Goldman, Sachs would refuse to represent aggressors, although it would sometimes offer them advice. Gradually Wall Street divided into two camps—the offensive (Morgan Stanley, First Boston, Drexel Burnham, Merrill Lynch, and Lazard Frères) and the defensive (Goldman, Sachs; Kidder, Peabody; Salomon Brothers; Dillon, Read; and Smith, Barney). And Joe Flom would consistently square off against defense specialist Marty Lipton.

  ESB did bring in a white knight—Harry Gray of United Aircraft (later United Technologies), who leapt into a bidding war that sent the battery maker’s price far above the initial bid. Spurred on by Greenhill, Inco delivered a knockout blow, boosting its final bid from $38 to a victorious $41 a share in a day. Inco was suddenly worth more than twice as much as before the frenetic bidding began.

  Greenhill would remember Inco nostalgically, whereas Frank Petito would prove more sober and ambivalent about the hostile raids legitimated by Morgan Stanley. “Many did not work out,” he later said. “But you’ve got to remember what the times were like. And it was always management that wanted to do them.”37 This was Morgan Stanley gospel in the 1970s—that the firm was a passive instrument of its clients, even a somewhat unwilling party. Greenhill insisted, “Wall Street had not created the merger trend. . . . We get the transactions done.”38 If this deterministic view spared the firm responsibility, it also betrayed some unspoken uneasiness. Greenhill could never quite mouth the words hostile or unfriendly. “We prefer not to call them unfriendly takeovers,” he told Business Week in 1974. “Just because the management doesn’t go along doesn’t mean that the deal isn’t in the best interest of the stockholders, and Morgan Stanley would never allow itself to get so involved in a deal that wasn’t.”39

  Like Robert Young’s New York Central raid, Inco-ESB would show the shot-in-the-dark quality of hostile takeovers. When Greenhill swooped down on Fred Port, the company had just registered record earnings of over $300 million for its fiscal year. For all its promises, Inco couldn’t improve on that. ESB slipped in its rivalry with Dura-cell batteries and the Delco-Sears maintenance-free car battery. By 1980, it was losing money, and its new chairman, Chuck Baird, put ESB up for sale, professing discomfort with its retail-oriented business. That Bob Greenhill was later wistful about Inco-ESB says much about the way in which investment banking was becoming disconnected from the economic realities of jobs, factories, and people. By what logic could the takeover be construed as a victory? Investment bankers were beginning to take a shorter-term view of their clients’ businesses.

  Once Morgan Stanley sanctioned hostile takeovers, competitors jumped in. A year later, George Shinn of First Boston paired up Bruce Wasserstein and Joe Perella to launch a separate M&A operation. In 1974, $100 million was still considered a big deal. By 1978, over eighty deals exceeded that amount, with a $500- to $600-million range already commonplace. Unlike the conglomerate takeovers of the 1960s, which were financed with the shares of the acquiring company, the new takeovers were largely effected with cash. Because Morgan Stanley booked fees as a percentage of the total, its profits soared.

/>   Like the trading operation, takeover work helped to diversify the firm. Three female professionals were assigned to the M&A Department. Yet Greenhill and his male colleagues erected a wall around the women and segregated them as “statisticians.” Their wives also conspired to relegate the women to second-class status: when the unmarried Morgan Stanley women were about to travel to London and Cleveland on takeover business, two irate wives called, squawking about the arrangement. No Morgan Stanley woman would make managing director until the mid-1980s.

  The Wall Street move into merger work accelerated into a stampede after May 1, 1975, when the SEC abolished fixed commissions on stock trades. This stripped away an easy, dependable flow of revenue and forced securities houses to forage for new business. Morgan Stanley, which now executed block trades for institutions, lobbied hard against the measure. Borrowing a term from his navy days, Bob Baldwin warned that “Mayday” might prompt the failure of 150 to 200 regional firms—an alarming forecast that proved on the low side. Morgan Stanley regarded these regional firms as possible buffers against retail giants like Merrill Lynch. As head of a wholesale firm long reliant on regional brokers, Baldwin was reluctant to see the demise of his cherished world of syndicates.

  When “Mayday” arrived, in 1975, Morgan Stanley tried to buck the tide and cling to old rates. Unsubstantiated rumors spread through Wall Street that the firm might blackball from its syndicates any firms that stooped to price cutting—a charge Baldwin labeled an “outrageous lie.” It was impossible, however, to hold back a sea of change, and commission rates plunged 40 percent for institutional investors. From these ashes arose the new, piratical Wall Street. Even conservative firms began adopting tactics once considered suitable only to disgruntled outsiders. In the Inco-ESB takeover, it was Morgan Stanley, the flagship of Wall Street, that first unfurled the Jolly Roger, and it would sail it through increasingly troubled seas.